The Indispensability of Risk

Episode Summary

Executive Summary: Howard Marks argues that risk is indispensable to investment success: avoiding it may reduce losses, but it also caps returns and can lead to insufficient wealth or underperformance. Using chess, backgammon, and sports analogies, he explains that superior long-term results usually come from many reasonable decisions, some losses, and a few big winners—not from a flawless record.

Main Topics: Risk as the price of reward (Priority: 5/5): Marks frames investing as a tradeoff: meaningful gains generally require accepting uncertainty and the possibility of loss. Without risk, returns are limited or absent. Chess and sacrifice as an investing analogy (Priority: 5/5): He uses a chess article about sacrifice to distinguish between 'sham' sacrifices with calculable benefits and real sacrifices where outcomes are uncertain, paralleling investments that require giving up certainty for potential upside. The risk of not taking risk (Priority: 5/5): Marks emphasizes that avoiding risk is itself risky because it can lead to inadequate returns for individual investors or failure to meet benchmark/client expectations for professionals. Backgammon and tactical risk decisions (Priority: 4/5): Backgammon illustrates the need to choose when to expose oneself to risk; beginners often play too safely and lose more often, reinforcing the idea that excessive caution can be costly. Long-term success comes from a portfolio of outcomes (Priority: 5/5): He argues that great performance usually reflects many decent decisions, a few major winners, and relatively few big losers rather than consistent perfection. Skillful, disciplined risk-taking (Priority: 4/5): Marks closes by noting that taking risk is necessary but not sufficient; it must be intelligent, well-reasoned, and emotionally controlled.

Key Arguments: Investing, like chess, requires sacrificing certainty in pursuit of potentially higher gains. A 10-year U.S. Treasury is a 'modest' or 'sham' sacrifice because the tradeoff is clear and the return is certain, unlike most investments. Markets are efficient enough that easy, high-return/low-risk opportunities are usually unavailable because other participants are not foolish. The real choice is often between no risk/no return, modest risk/modest return, or high uncertainty/high potential gain with possible permanent loss. The danger of avoiding risk is underachieving: individuals may fail to fund living expenses, and professionals may miss benchmarks or client goals. Superior investing outcomes usually come from many decent bets, a few large winners held for a long time, and relatively few large losers. A strong record does not imply consistent success on every idea; it often reflects a favorable ratio of winners to losers and the size of wins versus losses. Taking risk should be based on sound reasoning and sufficient confidence in judgment, not on recklessness or emotional impulse.

Data Points: Memo date: April 17th, 2024 - Closing date of the memo/podcast episode. Wall Street Journal article date: April 12th - Howard Marks says the memo was prompted by a WSJ article sent by Bruce Karsh. Age in anecdote: 2 years old - Maurice Ashley describes his mother leaving him and his siblings in Jamaica when he was age 2. Family timeline: a decade later - Ashley’s mother reached her goal and brought her children to the U.S. about ten years later. Chess title reference: 5-time world chess champion - Magnus Carlsen is cited on the risk of not taking risks. Memo count reference: four decades - Marks notes he has written similar investing-vs-sports analogies in each decade of memo-writing.

Pivotal Quotes: "not being willing to take risks is an extremely risky strategy" — Magnus Carlsen: Used to underscore that risk avoidance can itself be the most dangerous choice. "No risk, no reward. No pain, no gain." — Maurice Ashley (quoted by Howard Marks): Summarizes the core investing lesson that reward requires exposure to uncertainty. "The bottom line on the quest for superior investment returns is clear. You shouldn't expect to make money without bearing risk." — Howard Marks: Marks’ concluding thesis on investing and the necessity of risk.

Implications: For investors, the message is to accept measured risk as unavoidable, while managing it intelligently. The goal is not zero losses, but a sound process that produces enough winners over time to outweigh inevitable setbacks.